Chemed - 10-Q quarterly report FY

As used herein, the terms "We," "Company" and "Chemed" refer to Chemed Corporation or Chemed Corporation and its consolidated subsidiaries.

We have prepared the accompanying unaudited consolidated financial statements of Chemed in accordance with Rule 10-01 of SEC Regulation S-X.  Consequently, we have omitted certain disclosures required under generally accepted accounting principles in the United States (“GAAP”) for complete financial statements.  The December 31, 2007 balance sheet data were derived from audited financial statements but do not include all disclosures required by GAAP.  However, in our opinion, the financial statements presented herein contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly our financial position, results of operations and cash flows.  These financial statements are prepared on the same basis as and should be read in conjunction with the Consolidated Financial Statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2007.  Certain 2007 amounts have been reclassified to conform with current period presentation on the balance sheet related to the presentation of Medicaid nursing home pass-through activity at our VITAS subsidiary.

Service revenues and sales and after-tax earnings by business segment are as follows (in thousands):

 

Beginning on January 1, 2008, the income statement impact of our deferred compensation plans covering Roto-Rooter employees has been classified as a Corporate activity.  Historically, the income statement impact has been recorded as a Roto-Rooter activity.  Due to the volatility in the capital markets, Roto-Rooter’s operational results were being distorted in our management reporting as a result of the activity of the deferred compensation plans.  Our Chief Operating Decision Maker, Kevin McNamara, determined that the income statement impact of Roto-Rooter’s deferred compensation plans is more appropriately classified as a Corporate activity.  Our internal management reporting documents have been changed to reflect this determination.  The comparable prior-year period has been reclassified to conform to the current-year presentation.

Both the VITAS segment and Roto-Rooter segment recognize service revenues and sales when the earnings process has been completed.  Generally, this occurs when services are provided or products are delivered.  VITAS recognizes revenue at the estimated realizable amount due from third-party payers.  Medicare payments are subject to certain caps, as described below.

As of September 30, 2008, VITAS has approximately $12.1 million in unbilled revenue included in accounts receivable (December 31, 2007 - $9.5 million).  The unbilled revenue at VITAS relates to hospice programs currently undergoing focused medical reviews (FMR).  During FMR, surveyors working on behalf of the U.S. Federal government review certain patient files for compliance with Medicare regulations.  During the time the patient file is under review, we are unable to bill for care provided to those patients.  During the past year, the pace of FMR activity has increased industry-wide, resulting in our significant unbilled revenue balances.  We make appropriate provisions to reduce our accounts receivable balance for potential denials of patient service revenue due to FMR activity.

 

We actively monitor each of our hospice programs, by provider number, as to their specific admission, discharge rate and median length of stay data in an attempt to determine whether they are likely to exceed the annual per-beneficiary Medicare cap (“Medicare cap”).  Should we determine that revenues for a program are likely to exceed the Medicare cap based on projected trends, we attempt to institute corrective action to influence the patient mix or to increase patient admissions.  However, should we project our corrective action will not prevent that program from exceeding its Medicare cap, we estimate the amount of revenue recognized during the period that will require repayment to the Federal government under the Medicare cap and record the amount as a reduction to patient revenue.  The Medicare cap measurement period is from September 29 through September 28 of the following year for admissions and from November 1 through October 31 of the following year for revenue.  As of the date of this filing, for the 2007 and 2008 measurement periods, we estimate that no programs have a required Medicare billing reduction.  Therefore, no revenue reduction for Medicare cap has been recorded for the three or nine-month periods ended September 30, 2008.

Earnings per share are computed using the weighted average number of shares of capital stock outstanding.  Earnings and diluted earnings per share for 2008 and 2007 are computed as follows (in thousands, except per share data):

 

For each of the three and nine month periods ended September 30, 2008, 829,000 stock options were excluded from the computation of diluted earnings per share as their exercise prices were greater than the average market price for most of the quarter.  No stock options were excluded for the comparable period in 2007.

Diluted earnings per share may be impacted in future periods as the result of the issuance of our $200 million Convertible Notes and related purchased call options and sold warrants.  Under EITF 04-8 ”The Effect of Contingently Convertible Instruments on Diluted Earnings per Share” and EITF 90-19, we will not include any shares related to the Convertible Notes in our calculation of diluted earnings per share until our average stock price for a quarter exceeds the conversion price of $80.73.  We would then include in our diluted earnings per share calculation those shares issuable using the treasury stock method.  The amount of shares issuable is based upon the amount by which the average stock price for the quarter exceeds the conversion price.  The purchased call option does not impact the calculation of diluted earnings per share as it is always anti-dilutive. The sold warrants become dilutive when our average stock price for a quarter exceeds the strike price of the warrant.

The following table provides examples of how changes in our stock price impact the number of shares that would be included in our diluted earnings per share calculation.  It also shows the impact on the number of shares issuable upon conversion of the Notes and settlement of the purchased call options and sold warrants:

Other (expense)/income -- net comprise the following (in thousands):

 

We are in compliance with all debt covenants as of September 30, 2008.  We have issued $27.3 million in standby letters of credit as of September 30, 2008 mainly for insurance purposes.  Issued letters of credit reduce our available credit under the revolving credit agreement.  As of September 30, 2008, we have approximately $147.7 million of unused lines of credit available and eligible to be drawn down under our revolving credit facility, excluding the expansion feature.

On May 19, 2008, the Compensation/Incentive Committee of the Board of Directors (“CIC”) approved a grant of 508,600 stock options to certain employees.  The stock options vest ratably over three years from the date of issuance.  The cumulative compensation expense related to the stock option grant is $5.3 million and will be recognized ratably over the three year vesting period.  We used the Black-Scholes option valuation method to determine the cumulative compensation expense of the grant.

On February 13, 2008, the CIC approved a grant of 40,315 shares of restricted stock to certain key employees.  The restricted shares cliff vest four years from the date of issuance.  The cumulative compensation expense related to the restricted stock award is $2.1 million and will be recognized ratably over the four-year vesting period.  We assumed no forfeitures in determining the cumulative compensation expense of the grant.

The Roto-Rooter segment sublicenses with approximately sixty-three independent contractors to operate certain plumbing repair and drain cleaning businesses in lesser-populated areas of the United States and Canada.  As of September 30, 2008, we had notes receivable from our independent contractors totaling $1.7 million (December 31, 2007 - $1.6 million).  In most cases these loans are fully or partially secured by equipment owned by the contractor.  The interest rates on the loans range from zero to 8% per annum and the remaining terms of the loans range from 2 months to 5 years.  During the three months ended September 30, 2008, we recorded revenues of $5.3 million (2007 - $5.3 million) and pretax profits of $2.5 million (2007 - $2.3 million) from our independent contractors.  During the nine months ended September 30, 2008, we recorded revenues of $16.5 million (2007 - $16.2 million) and pretax profits of $7.6 million (2007 - $7.1 million) from our independent contractors.

We have adopted the provisions of Financial Accounting Standards Board ("FASB") Interpretation No. 46R "Consolidation of Variable Interest Entities--an interpretation of Accounting Research Bulletin No. 51 (revised)" ("FIN 46R") relative to our contractual relationships with the independent contractors.  FIN 46R requires the primary beneficiary of a Variable Interest Entity ("VIE") to consolidate the accounts of the VIE.  We have evaluated our relationships with our independent contractors based upon guidance provided in FIN 46R and have concluded that some of the contractors who have loans payable to us may be VIE’s.  We believe consolidation, if required, of the accounts of any VIE’s for which we might be the primary beneficiary would not materially impact our financial position, results of operations or cash flows.

All of the Company’s plans that provide retirement and similar benefits are defined contribution plans.  Expenses for the Company’s pension and profit-sharing plans, excess benefit plans and other similar plans were $838,000 and $2.0 million for the three months ended September 30, 2008 and 2007, respectively.  Expenses for the Company’s pension and profit-sharing plans, excess benefit plans and other similar plans were $6.3 million and $9.7 million for the nine months ended September 30, 2008 and 2007, respectively.

VITAS is party to a class action lawsuit filed in the Superior Court of California, Los Angeles County, in September 2006 by Bernadette Santos, Keith Knoche and Joyce White (“Santos”).  This case alleges failure to pay overtime and failure to provide meal and rest periods to a purported class of California admissions nurses, chaplains and sales representatives.  The case seeks payment of penalties, interest and Plaintiffs’ attorney fees.  VITAS contests these allegations.  The lawsuit is in its early stages and we are unable to estimate our potential liability, if any, with respect to these allegations.

In April 2007, our Roto-Rooter subsidiary was named in a class action lawsuit filed in San Mateo Superior Court by Stanley Ita (“Ita”) alleging class-wide wage and hour violations at one California branch.  This suit alleges failure to provide meal and break periods, credit for work time beginning from the first call to dispatch rather than arrival at first assignment and improper calculations of work time and overtime.  The case sought payment of penalties, interest and Plaintiffs’ attorney fees.  After the suit was filed, we offered a settlement to certain members of the class and paid approximately $200,000.  In January 2008, we agreed to a tentative settlement with the remaining members of the class for approximately $1.8 million.  The tentative settlement was preliminarily approved by the court in May 2008.  Final approval and payment of the settlement was made in August 2008.  The settlement was accrued in the fourth quarter of 2007.

Regardless of outcome, defense of litigation adversely affects us through defense costs, diversion of our time and related publicity.  In the normal course of business, we are a party to various claims and legal proceedings.  We record a reserve for these matters when an adverse outcome is probable and the amount of the potential liability is reasonably estimable.

In April 2005, the Office of Inspector General (“OIG”) for the Department of Health and Human Services served VITAS with civil subpoenas relating to VITAS’ alleged failure to appropriately bill Medicare and Medicaid for hospice services.  As part of this investigation, the OIG selected medical records for 320 past and current patients from VITAS’ three largest programs for review.  It also sought policies and procedures dating back to 1998 covering admissions, certifications, recertifications and discharges.  During the third quarter of 2005 and again in May 2006, the OIG requested additional information from us.  The Court dismissed a related qui tam complaint filed in U.S. District Court for the Southern District of Florida with prejudice in July 2007.  The plaintiffs are appealing this dismissal.  Pretax expenses related to complying with OIG requests were immaterial for the three and nine months ended September 30, 2008 and 2007.

The government continues to investigate the complaint’s allegations.  We are unable to predict the outcome of this matter or the impact, if any, that the investigation may have on our business, results of operations, liquidity or capital resources.  Regardless of outcome, responding to the subpoenas and defending the litigation can adversely affect us through defense costs, diversion of our time and related publicity.

In October 2004, VITAS entered into a pharmacy services agreement ("Agreement") with Omnicare, Inc. ("OCR") whereby OCR provides specified pharmacy services for VITAS and its hospice patients in geographical areas served by both VITAS and OCR.  The Agreement has an initial term of three years that renews automatically for one-year terms.  Either party may cancel the Agreement at the end of any term by giving written notice at least 90 days prior to the end of said term.  In June 2004, VITAS entered into a pharmacy services agreement with excelleRx.  The agreement has a one-year term and automatically renews unless either party provides a 90-day written termination notice.  Subsequent to June 2004, OCR acquired excelleRx.  Under both agreements, VITAS made purchases of $8.3 million and $8.6 million for the three months ended September 30, 2008 and 2007, respectively.  Under both agreements, VITAS made purchases of $24.8 million and $25.1 million for the nine months ended September 30, 2008 and 2007, respectively.  VITAS has accounts payable to OCR of $960,000 at September 30, 2008.

Mr. E. L. Hutton is non-executive Chairman of the Board and a director of the Company.  He was a director of OCR until his retirement in the first quarter of 2008 at which time he assumed the honorary post of Chairman Emeritus of OCR’s Board.  Mr. Joel F. Gemunder, President and Chief Executive Officer of OCR., Ms. Andrea Lindell and Ms. Sandra Laney are directors of both OCR and the Company. Mr. Kevin J. McNamara, President, Chief Executive Officer and a director of the Company, is a director emeritus of OCR.  We believe that the terms of these agreements are no less favorable to VITAS than we could negotiate with an unrelated party.

On September 30, 2008, we had $3.7 million in a mutual fund investing in U.S. Treasury securities.  We closely monitor the creditworthiness of the institutions with which we invest our overnight funds and the quality of the collateral underlying those investments.

Included in accounts payable at September 30, 2008 is cash overdrafts payable of $7.8 million (December 31, 2007 - $9.5 million).

On May 19, 2008 our Board of Directors authorized an additional $56 million to the April 2007 stock repurchase program.  For the nine months ended September 30, 2008 and 2007, we repurchased approximately 1.7 million shares at a weighted average cost of $39.73 per share and 2.1 million shares at a weighted average cost of $59.82 per share, respectively.

On January 1, 2008, we partially adopted the provisions of Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”).  This statement defines a hierarchy which prioritizes the inputs in fair value measurements.  Level 1 measurements are measurements using quoted prices in active markets for identical assets or liabilities.  Level 2 measurements use significant other observable inputs.  Level 3 measurements are measurements using significant unobservable inputs which require a company to develop its own assumptions.  In recording the fair value of assets and liabilities, companies must use the most reliable measurement available.  There was no impact on our financial position or results of operations upon adoption of SFAS 157.   We have elected to partially defer adoption of SFAS 157 related to our goodwill and indefinite lived intangible assets in accordance with FASB Staff Position No. 157-2.

As of September 30, 2008, we hold $28.9 million of investments in mutual funds and company owned life insurance policies in a Rabbi Trust related to certain of our deferred compensation plans.  These investments are valued using quoted prices in active markets for identical investments (Level 1).  We do not hold any financial assets for which the market for that asset is inactive.

In June 2008, the EITF reached a consensus on EITF Issue No. 07-5, “Determining Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity’s Own Stock”.  The consensus provides additional guidance when determining whether an option or warrant on an entity’s own shares are eligible for the equity classification provided for in EITF 00-19.  The consensus is effective for fiscal years beginning after December 15, 2008.  We are currently evaluating the impact of this consensus on our outstanding options and warrants issued in connection with our 2007 convertible debt transaction.

In May 2008, the FASB issued Staff Position No. APB 14-1, “Accounting for Convertible Debt Instruments that may be Settled in Cash Upon Conversion (Including Partial Cash Settlement).”  This new guidance requires all convertible debentures classified as Instruments B or C under EITF 90-19 to separately account for the debt and equity pieces of the instrument.   At inception of the convertible instrument, cash flows related to the convertible instrument are to be discounted using a market rate of interest.  This will create a discount at inception to be recorded in equity.  The debt portion is to be accreted to its face value, through interest expense, over the life of the instrument using the effective interest method.  This will result in higher interest expense over the life of the instrument and an increase in equity at the inception of the instrument.  Debt issuance costs are also to be allocated between the debt and equity components using a rationale method.  Finally, the FSP requires that the Company value any embedded features of the instrument, other than the conversion option, as a part of the liability.  The new standard is effective for all fiscal years (and interim periods) beginning after December 15, 2008.  As such, we will adopt the new standard on January 1, 2009.  The FSP is to be applied retrospectively.  Upon adoption, our preliminary estimate is that our $200 million, 1.875% Convertible Debentures issued in May 2007 will have a discount of between $50 million and $60 million.

In May 2008, the FASB issued Statement of Financial Accounting Standard No. 162 “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”).  The purpose of this standard is to provide a consistent framework for determining what accounting principles should be used when preparing U.S. GAAP financial statements.  SFAS 162 categorizes accounting pronouncements in a descending order of authority.  In the instance of potentially conflicting accounting principles, the standard in the highest category must be used.  This statement will be effective 60 days after the SEC approves the Public Company Accounting and Oversight Board’s related amendments.  We believe that SFAS 162 will have no impact on our existing accounting methods.

In December 2007, the FASB issued Statement of Financial Accounting Standard No. 141(R) “Business Combinations (revised 2007)” (“SFAS 141(R)”), which changes certain aspects of the accounting for business combinations.  This Statement retains the fundamental requirements in Statement No. 141 that the purchase method of accounting be used for all business combinations and for an acquirer to be identified for each business combination.  SFAS 141(R) modifies existing accounting guidance in the areas of deal and restructuring costs, acquired contingencies, contingent consideration, in-process research and development, accounting for subsequent tax adjustments and assessing the valuation date.  This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date.  There will be no impact on our financial statements as a result of the adoption of SFAS 141(R); however our accounting for all business combinations after adoption will comply with the new standard.

In December 2007, the FASB issued Statement of Financial Accounting Standard No. 160 “Non-controlling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS 160”), which requires ownership interests in subsidiaries held by others to be clearly identified, labeled and presented in the consolidated balance sheet within equity but separate from the parent company’s equity.  SFAS 160 also affects the accounting requirements when the parent company either purchases a higher ownership interest or deconsolidates the equity investment.  This Statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity may not apply it before that date.  We currently do not have non-controlling interests in our consolidated financial statements.

 

Our 1.875% Notes are fully and unconditionally guaranteed on an unsecured, joint and severally liable basis by certain of our 100% owned subsidiaries.  The following unaudited, condensed, consolidating financial data presents the composition of the parent company (Chemed), the guarantor subsidiaries and the non-guarantor subsidiaries as of September 30, 2008 and December 31, 2007 for the balance sheet and the three and nine months ended September 30, 2008 and 2007 for the income statement and the statement of cash flows (dollars in thousands):